Massive inflows of cash into the US financial system from elsewhere around the world boosted liquidity indicators last week and kept a bid under US financial asset prices. Under normal circumstances, in the absence of quantitative easing we would expect prices to fall, but these are not normal circumstances. It’s not a matter of investors seeing the US as a good place to invest. It’s that everywhere else looks even worse.
Capital flight out of foreign markets into the US is evident in a number of indicators. US bank accounts are surging. Banks have so much cash that they’ve been forced to commit some of it to the Treasury market for the first time in months. They had been avoiding Treasuries like the plague. How ironic that as Debtmaggedon comes ever closer, they are forced to buy them at near record high prices and low yields. On the surface, it makes no sense, but when you consider that we live in a world where everything is relative, to many investors the US still looks like the least bad option. I guess they never heard of gold.
I’ve also thought that there may be a short squeeze at work here. Primary Dealers had built a massive short position in Treasuries by May which they have been furiously covering ever since. The latest data through early July showed the pace of their short covering to be increasing. The losses have to be hurting them, and could be cause for more market weakness once the buying panic, and capital flight out of Europe and into the US, subsides.
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